You are here

Will Finding My Leases Uncover New Savings Opportunities?

Blog Post
July 7, 2017

Will Finding My Leases Uncover New Savings Opportunities?

By Mike Hammerslag

The upcoming FASB changes have firms searching for leases in the most unlikely places.

In this example, a real estate executive found leases in the file cabinet of his Chief Marketing Officer. After some investigation and analysis, they were able to save millions in capitalized rent and gain favorability with the landlord.

Senior management had tasked me with heading up our new lease accounting project, and as I had been with our firm for more than a decade, I felt confident about my understanding of our business processes. As I was nearing the end of my efforts to collect all the necessary lease data, I set meetings with a few of our firm’s key executives to find out how they managed their segment of the business.

I sat down with our Chief Marketing Officer. He said that while the Real Estate department handled all location leases, his group planned for the physical marketing at the location. This meant all that signage in the marketplace was leased – and upon drilling down – I found they had, on average, 10 signage leases per location that ran more than 12 months. He pointed to a long wall of filing cabinets and said,

“I’ve got all of the current, active leases in there – probably near 2,500.”

As I inventoried the collection of signage leases, I noticed that the first lease I pulled had an initial 5-year term, followed by four 5-year options. Upon further review, it became clear that we had executed three of the four options. Randomly selecting another nine leases, I saw that they, too, had an identical term structure and most of them had the same number of options executed. I wondered if this small sample was representative of the overall portfolio?

To answer this, we needed to investigate the existing (and expired) lease portfolio to determine the proper length of time to attribute to the “likely” lease period:

Based on the overall portfolio size, we determined that we should sample about 500 leases (or roughly 20% of the portfolio).

We split those leases over four major geographic areas (about 125 leases per area) to determine if the signage’s location influenced the data.

We then decided to segment the data by decade to determine if the number of exercised options was increasing or decreasing.

Here is what we determined:

Area

Number of Leases

Average Options Exercised

1970s

1980s

1990s

2000s

2010s

Northeast

120

3

4

4

3

2

3

Southeast

130

4

4

4

4

4

4

Central

125

2

1

2

2

3

2

West

125

2

3

3

2

1

1

As we analyzed our findings, we determined that while we routinely executed 3 of the 4 available options (Small Sample), the location of the signage skewed the data (Average Options). When we analyzed both the location and decade, we found the data skewed even further (Normalized Options):

Area

Small Sample

Average Options

Normalized Options

Northeast

3

3

3

Southeast

3

4

4

Central

3

2

2

West

3

2

1

Weighted Average

3.00

2.76

2.51

Our Findings

Based on the research, we derived the following:

1. Terms

If we had used the Average Options calculations, we would have capitalized roughly 8% less than the Small Sample. However, using geography and time as variables (Normalized Options), we discovered a savings of over 16% for the “likely” lease period. (Calculations: 3.00-2.51 = .49/3.00 = .163)

This finding significantly increased the savings to our anticipated $100M in capitalized rent:

Anticipated Add to Balance Sheet

Percentage Savings

Dollar Savings

$100M

16%

$16M

2. Rent

Since we had routinely executed the first option, we decided to change our overall leasing strategy to an initial 10-year period followed by three (instead of four) option periods. With the extended base-term length, which lessened the risk to the landlord, we negotiated a reduction in the base rent over the initial 10-year period.

As you begin to collect your leases, it’s best to put together a team to assist in the investigation of their location across the company. We also found that tackling the new financial regulations required new analysis, but done correctly – we discovered a 16% savings to our anticipated capitalized rent and were able to negotiate a reduction in base rent.

About the AuthorMike Hammerslag, MSRE, MBA, CPM, MCR, began his real estate career in 1988 when he joined The Rockefeller Group, Inc., and has never left the industry. Mike’s career has allowed his involvement in nearly every aspect of real estate—from research, strategy, and leasing to management and ownership. Overall, he brings an unparalleled view of strategic real estate management and financial oversight as Senior Product Manager and our resident FASB/IASB expert.